TMFDeej (97.73)

Now is the time to buy natural gas - Part 2

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On May 28th, I wrote an article stating that natural gas prices are poised to rally significantly over the next year (see post: Now is the time to buy natural gas). Natural gas prices have risen 5% since then and I strongly believe that they have a lot more room to run.

I came across two articles this weekend that support my theory. The first is Michael Santoli's weekly column in Barron's. According to his article, the ratio of a barrel ofoil to a thousand cubic feet of natural gas rose to 18-to-1 last week. This is the highest this ratio has been since 1990 - 1991. Each of the past three times that the oil/gas ratio exceeded 18 in the aforementioned period it proved to be an excellent time to bet on gas relative to oil. Twice nat gas dramatically outperformed oil and once its outperformance was "merely impressive."

An article from Bloomberg this morning titled Natural Gas Cheapest to Oil Since 1992 Signals Gain states the same thing. While other commodities are rallying sharply nat gas has been hammered, falling 31% year to date and 72% over the past eleven months. Part of the reason for this is that even though LNG (liquefied natural gas) can be transported, in general nat gas is more of a local commodity while the things that are rallying like oil, copper, etc... are more easily transported. Investors believe that Asia will recover more quickly than the U.S. and its appetite for commodities will cause transportable commodities to outperform. I don't disagree with that sentiment, just with the degree of the outperformance.

At 18, Bloomberg states that the oil/gas ratio is at its highest level since 1992. This ratio has averaged only 8.4 over the past decade. The analysts surveyed by Bloomberg expect nat gas top rally 38% during the remainder of the year, from their current $3.858 of $6.50 per million Btu in Q4.

The number of U.S. rigs drilling for it has fallen 56% over the past nine months. The U.S. gas rig count dropped to 700 last week, its lowest level since 2002.

Bernstein Research recently stated that natural gas needs to rally to $7.50 to spur enough production to meet demand, known in the industry as the marginal cost of supply. They believe that nat gas will more than double to $9 - $10 by the end of '09. While I am not personally quite that bullish, I strongly believe that nat gas will be a fantastic investment over the next twelve months.

Similarly, ConocoPhillips (COP) believes that natural gas will increase to $6 to $8 as early as next year as demand recovers. John Wright, the company's president for gas and power marketing, was recently quoted as saying “I don’t think the levels that we’re at now will provide the supply needed to meet demand, and that says prices will go up from here."

I am much more bullish on oil than natural gas long-term. Unlike oil production which has peaked in the United States, we are absolutely swimming in nat gas. It's there for the taking if we want it. Once prices rally, the rig count will rise again and drive prices back down. Furthermore, I strongly believe that the U.S. is entering a period of slower growth than we have experienced over the past several decades. Since demand from factories and power plants accounts for 58% of total gas demand, slow growth will act as a drag upon prices going forward. For now, I believe that the rig count has fallen so rapidly that nat gas could rally significantly over the next year.

At this point, I think that natural gas is cheap, but the question is --- how to play it (as alexpaz asks above)? Even if nat gas is cheap, many of the nat gas producers stocks are not. I like natural gas service related companies (such as DWSN) a bit more than the producers, but most of them have experienced a bit of a run up, too, at this point.

Thanks for reading everyone. The nat gas ETF is UNG. If you don't play futures directly, and most normal humans...myself included don't, that is an easy way to play this theory.

Many people are recommending a UNG long paired with an oil (USO) short to play a narrowing of the oil/gas ratio.

If playing gas directly isn't your thing, a ton of companies will benefit if gas prices rise, including CHK, XTO, COP, and other E&P (exploration & production) companies. I personally prefer E&P to drillers, but a case can be made for picking up drillers like PDS and NBR on the cheap as well.

I personally prefer companies that pay large dividends. I am playing nat gas through my exposure to a CANROY. CANROYs are similar to U.S. MLPs (for now...until the tax laws change). A number of great MLPs are out there as well.

Good blog post. EROC is another good NG play. Some will say it has poor fundamentals, but it basically mirrors NG valuations and fluctuates with the general market, but it has an enormous upside while it's downside has been all but obliterated. If you can wait until winter rolls around, I believe it should be a nice double if not better, from it's current position.

you should also mention that the proliferation of LNG should level the price of natural gas (geographically) and might also lead to a more stable oil to natural gas price ratio (via arbitrage/conversion). just a quick thought. i would have to look into that.